In case you missed it, check out the October 7, 2010 Daily Show’s send up of one version of the “Who’s-to-Blame for the Mortgage Crisis” as The Daily Show and Wyatt Cenac chronicle the Mortgage Bankers of America’s self righteous preaching of the moral obligation to pay a mortgage in the face of declining values…despite its own default of a $79 million loan on their own HQ building because it was underwater.
Apparently, the rest of us have a moral obligation to pay mortgages on underwater real estate, but the Mortgage Bankers Association of America, the professional organization that includes your mortgage lender, doesn’t. I wonder who MBA screwed and if they’re feeling as magnanimous.
If you’re losing sleep about whether or not your bank is hurting, watch this.
As this dog-tired economy continues to drag on, with no relief in sight and no bounce-back in home prices appearing anywhere on the horizon, the single question I am asked most frequently is “Should I walk away from my mortgage, and if I choose to do that, what are my options?”
Usually it comes in the following form. “We bought our house in 200_, for $_______. It’s now worth less than what we paid, and less than the outstanding loan amount. We’re considering our options, but are not sure what to do.”
Sometimes this question comes up because someone has lost a job, or is in the real estate business and hasn’t been able to generate much commission income in the past 2 to 4 years, although sometimes it’s just the economics themselves that trigger the inquiry.
The question about what to do, however, is less a legal decision than it is an economic decision. Of course, once you decide to walk away, then the follow-through becomes a purely legal act, and should only be undertaken after consulting with legal counsel and obtaining a full understanding of what is likely to happen.
First, should you? That all depends on where you think housing prices are going to go in the future, how long you’re willing to tough it out and what your other housing options look like. Obviously, you have to live somewhere, so if you’re not going to own, then you have to have a good understanding of what your rental options are Example: A family of four, with two teenagers, living in a 1,500 square foot house in an expensive neighborhood is going to be looking at a very different set of concerns than a childless couple living in a 4,000 SF home in an affordable location. That seems obvious, but to many folks it apparently isn’t.
So it’s not a straight dollars and cents analysis. Just because your home is worth 20% less than the balance on your loan, no lawyer can advise you on whether you should keep the house and keep paying, or let it go and brave the consequences. All a lawyer can do is tell you what is likely to happen under any particular course of action.
Next, if you do decide to walk away, what is going to happen? Well, we all know that such a decision is going to cause significant credit problems. It’s inevitable: If you walk away from a home loan, your credit is going to suffer. But what else?Fortunately, we don’t have debtor’s prison, so despite the loss of the house to foreclosure–another inevitability although the timing may vary depending on circumstances–you may get sued. Obviously that’s no fun, and is something that you should try to avoid, but whether that is likely to happen or not is a very good question to take up with a lawyer. We’re lucky in California as there are very powerful anti-deficiency laws, about which I have already blogged rather extensively. (See California anti-deficiency rules and statutes: When can a mortgage lender in California recover a deficiency after foreclosure?, California Mortgage Deficiencies: What is a Purchase Money Security Interest? and Second Mortgages in California: Deficiencies Not Usually an Issue for full treatment of the subject.)
Last, what about staying and trying to complete a mortgage modification? I’m sorry to say that I’m a cynic on this subject. The process seems capricious and arbitrary at best, and since my experience leads me to the unshakable and firm conviction that, as a class of people, consumer bankers are among the dumbest clowns wandering the planet, the percentage likelihood of any one homeowner or family successfully completing a mortgage modification is nearly microscopic. This is especially true here in Northern California where incomes and home prices are among the highest in the country. They’re not much interested in modifying mortgages for people with six figure incomes and seven figure home prices. And of course, whether that is right or not is beside the point, but you need to understand the reality if you’re going to test the water.
Well, you know by now that the answer is: It depends.
If you file Chapter 7, and either are current or get current with your mortgage(s), then you can most likely keep your home. (Assuming you don’t have an equity interest that exceeds the homestead exemption. As to which, see this blog post: California Homestead Exemptions Increased as of January 1, 2010. Other California Bankruptcy Exemptions will increase on April 1, 2010.)
If however, you are in arrears, and are not able to bring the loan current, then–unless you can complete a mortgage modification that allows you to stay–you are likely lose the home.
On the other hand, if you file Chapter 13, and are able to successfully get a payment plan approved by the Court, then you may be able to stay. This is because in a Chapter 13, you can take the outstanding mortgage arrearages, and pay them back through the Chapter 13 plan over the 3 to 5 year commitment.
But don’t try to do this analysis yourself. Talk to a bankruptcy lawyer before you get too excited. There are lots of nit-picky little rules that can torpedo an otherwise possible successful Chapter 13. You need to do the analysis up front.
The New York Times recently reported on a movement by the California State Legislature to amend California Code of Civil Procedure (“CCP”) §580b. (See “Battles in California over Mortgages.”) For those of you who’ve been following along, CCP §580b is the California statute that prohibits a mortgage lender from obtaining a deficiency judgment on any loan that was used to purchase or construct a residence. Such loans are referred to in the law as “purchase money loans.” I have posted about this a couple of times (See posts: California anti-deficiency rules and statutes: When can a mortgage lender in California recover a deficiency after foreclosure? and Second Mortgages in California: Deficiencies Not Usually an Issue), and it is a very important statute for California homeowners.
On June 3, 2010, the California Senate passed, by a convincing margin of 30 to 4, Senate Bill 1178 which extends the protections of CCP §580b to any loan taken out to refinance a purchase money loan, up to the amount of the original purchase money loan which is refi’d. Here’s how that works: I take out a loan for $500,000 which I use to buy my home. A few years later, I refinance that loan with a new loan for $700,000, $500k of which goes to take out the original purchase money loan, and the other $200k of which I use for other purposes. Under existing law, because the new loan is no longer a “purchase money loan,” but is a refi of a purchase money loan, I would not be protected against possible personal recourse by the lender if it foreclosed and did not recover enough on the sale of the residence to pay off the whole loan. Under the new law–if it passes the California State Assembly–I would still be protected on the refinance loan up to the amount of the original purchase money loan that was refinanced, or in my hypothetical, $50ok. That would leave me exposed on the balance in excess of that refinanced amount. In my hypothetical, up to $200k.
Do we care? Well, maybe some day someone will, but I doubt it.
As usual, the press gets it all muddled up, and everyone jumps on the band wagon to shout about “consumer protections.” It’s actually somewhat comical. If you Google “SB 1178 California” you get a whole raft of folks nattering about the great “consumer protections” it offers. But if you know anything at all about how the economics and law of foreclosure in California actually work in day-to-day reality, a little reflection shows that it doesn’t do anything of the sort.
As a Bay Area real estate and bankruptcy lawyer who lives on the front lines–representing both lenders and borrowers–in these sorts of disputes every day, I’ll go way out on a limb here, and say with confidence, and in my most stentorian tone of voice, that this is a bunch of hogwash. More political window dressing in the face of a crippling inability to do anything meaningful at all. It’s not going to solve a single one of the problems facing California’s real estate industry today, and in practice, its benefits–if any–will be limited to an extremely small group of people who have more money than brains. The investor who made a wrong bet, but who can still afford to pay their debts. (Which, ironically, is the precise subset that everyone who’s anyone in this debacle–from Hank Paulson to Bernard Bernanke to George Bush to the Barrack Obama–has steadfastly maintained they have no desire to help. But I digress.) Legally and economically, this is a red herring brought to you by a band of legislators who are largely powerless to do much more than wave their arms in sturm und drang trying to demonstrate to an increasing angry constituency that they are doing something.
Here’s why this thing is meaningless:
First, in order for this hypothetical to be a real problem, the lender would have to file an action for judicial foreclosure, because under the provisions of CCP §580d, no deficiency is available to a lender who forecloses by trustees sale. If the foreclosing lender has availed itself of the “power of sale clause” in the deed of trust, then no deficiency is allowed. Period, done finished, end of story. That’s what CCP §580d is all about. It doesn’t matter what the money was used for, how it was obtained, from whom, etc. No lawsuit, no deficiency. (A trustee’s sale is when they sell the property by auction on the Courthouse steps, and a judicial foreclosure is when they file a lawsuit in Superior Court seeking a judicial decree of foreclosure and money judgment.)
Second, the California real estate market continues to slog along the bottom of the river, which means that there are very few loans where the bank is going to be interested enough in the borrower to actually spend the time and money to chase a debtor on one of these. The costs of foreclosure are already sky-high, (found by a Joint US Congressional Economic Committee to approach an average of $80,000 (!!!), see Joint Congressional Economic Committee Report on Foreclosure Costs), and the added costs and uncertainties of trying to pursue a deficiency on a mortgage balance in a court only adds more time, expense and uncertainty. Banks–and the regulators who regulate them–hate time, expense and uncertainty when it has to do with a non-performing loan.
The fact is that most lenders are not going to spend the money to launch a judicial foreclosure on a generic breach of contract claim. Which is what this foofaraw is all about. When a borrower defaults on a promissory note by not paying it back it is just a simple, no-brainer breach of contract claim. Mortgage lenders in this sort of hypothetical don’t sue for that. Why? Because it’s a colossal, herculean, humongous and uncertain waste of time and money. And why is that? Because the person they’re chasing either doesn’t have the money to pay them back–which is why they’re not paying in the first place–which means that if they actually get a judgment it will be an uncollectible judgment, i.e., a meaningless wallpaper, and…And here’s the big one, a generic breach of contract claim on a promissory note is completely dischargeable in bankruptcy. The lender can chase the borrower all the way to judgment and the borrower can still squirt out by filing a simple $299 Chapter 7 petition.
The person that they will sue, however, is the scam artist who got the loan by fraudulent means, and there is nothing at all in the revised CCP §580b that is going to protect that scam artist from the consequences of their fraud.
So who is this new and improved law going to help? Here’s the profile: He/she is a borrower who doesn’t want to pay the loan back even though he/she has the money to do so. Further, they’re willing to spend this money that he doesn’t want to spend to avoid the foreclosure to finance litigation. Oh yeah, and one more data point. The National Consumer Law Center recently published a report on average hourly rates for experienced consumer law attorneys, experienced being defined as those with 20 to 30 years experience. Me and my colleagues in other words. (See NCLC United States Consumer Law Attorney Fee Survey) The result? $460 to $475 per hour. So this hypothetical borrower doesn’t want to pay his loan, but he’s willing to pay me or my colleagues $475 an hour to litigate this issue. Total likely fees? $50,000 to $100,000 at those rates. Where is this idiot?
So the new and improved CCP 580b is a pointless public relations stunt, and any blogger, journalist, banker, lawyer, real estate agent or politician who tells you otherwise is a well-intended liar or, more likely, just doesn’t know what they’re talking about. I suspect what they’ll say in response to me, however, is that removing this threat removes a negotiating plank–the threat of a lawsuit–from the lenders’ arsenal.
Last, the new law, if it passes, is likely only to apply to loans made after June 1, 2011.
Why do we care? Because since sometime in late, 2007, the jumbo market has been largely seized, with liquidity limited only to what could be sold to Fannie Mae and Freddie Mac. But those two are limited to mortgages of less than $730,000, which means that lending liquidity for the so-called “jumbo product” has ben almost non-existent. With median home prices in Marin County (usually) well above that amount, this has meant that financing for a significant chunk of the Marin market has been scarce as well.
Hopefully, this news is a harbinger of good things to come in the upper end of the Marin and other Bay Area markets.
Okay, so I was just about to draft a blog post on the new Federal loan modification/Housing Program Enhancements program that was announced today, when the NY Times blog “Bucks” scooped me. Ron Lieber and Jennifer Saranow Schultz have done a very good job hitting most of the big questions, and have done better than I probably would have…and without the legal mumbo jumbo. Follow the link above to read the original. It would not be proper for me to reprint it here without permission.
In a blog post on Planet Money titled The Latest Loan Modification: Don’t Get Your Hopes Up NPR is reporting today that Bank of America has decided that it will be cheaper and easier to reduce principal rather than interest on “severely under water loans.” Oh. B of A is saying that this new strategy could apply to as many as 45,000 loans, including some of the “exotic time bombs” it inherited when it acquired Countrywide Home Loans last year.
I’m not sure this is really news. As Chris Mayer, the Milstein Professor of Real Estate at Columbia University’s business school is quoted as saying, “they’re just stating the obvious, which is that they’re not going to get paid back in full.” Professor Mayer goes on to editorialize.”There is no great solution,” Mayer is reported as saying. “We’re going to muddle along.”
In a couple of other places in this blog I have discussed various components of California’s mortgage anti-deficiency laws. (See California Mortgage Deficiencies: What is a Purchase Money Security Interest? and Second Mortgages in California: Deficiencies Not Usually an Issue.) This post will put it all in one place. At least the five basic rules.
I can’t warn readers enough, however, that these are very, very complex issues. I have–quite intentionally–over simplified them here, and I have done this to provide a precis on the big picture. The case law interpreting the applicable statutes occupies volumes in California lawyers’ offices, and there are still many legal issues and questions that are unsettled. So please go easy if I don’t answer your specific question here. There is no way I can address all of the issues in one post, so if you have a specific question, please, post it in the comment section so everyone can see it, and I’ll do my best to answer it. But if you think you have a deficiency problem, or a possible exposure to a deficiency judgment, you really owe it to yourself to see an attorney who understands these issues. Also, bear in mind that the rules vary from state to state, so if you are reading this post with a real estate problem in any place other than California, you can be sure that the rules applicable to your situation are not the same.
First, what is a deficiency? Simply stated, a deficiency is what is left owed to a lender after the lenders forecloses and takes the real estate back. Example: If I owe $200,000, and the property is only worth $150,000 there is a so-called “deficiency” of $50,000. When can the lender come after the borrower for that “deficiency?” That is the subject of this post. And, of course, in the current economy, a lot of people are trying to figure this out.
In California, there are four primary rules that apply. I discuss them below in no particular order.
1. The One Action Rule. CCP §726(a).
The One Form of Action Rule basically says that the lender is required to chase the collateral first, and the debtor second…if it still can. A long, long time ago, a foreclosing lender could choose whether to foreclose on the collateral or go after the borrower personally for a money judgment. The one action rule of CCP §726(a) says that the lender must go after the collateral first, and, if it is legally possible, go after the borrower personally for any deficiency after that. Whether that is possible will depend on how the other rules set forth below kick in and apply to protect the borrower. But if you get sued on a promissory note and the lender is not a “sold out junior” nor taken hasn’t taken steps to foreclosure on the collateral, this rule would apply.
(I use the term “sold out junior quite a bit in this post. A sold out junior lienholder is the holder of a deed of trust that is junior to the first lienholder, and who has been denied a recovery due either to the foreclosure by the first lienholder, or because there isn’t enpugh value in the property to satisfy the junior debt after satisfaction of the senior debt. It is common for people to refer to such debts as “HELOCS,” but this isn’t technically accurate. A HELOC is simple a “home equity line of credit” that is secured by the subject property. It may be the most senior debt on the property or it may be a second, third…or tenth lien in order of its seniority. “HELOC” is a banking term; “sold out junior lienholder” is a legal term of art.)
2. The Purchase Money Prohibition: CCP §580b.
This is the best known rule and the one that applies more often than the others. If the loan that is being foreclosed on is a loan that was obtained for the purpose of purchasing the property, then no deficiency is allowed. It doesn’t matter if it’s a first, second or third. It doesn’t matter if it’s classified as a “HELOC,” a “seller carry back,” or, ultimately, a “sold out junior.” Purchase money is purchase money. Example: Homeowner buys a house for $300,000, with a first for $200, and a second for $60,000, both put on the property at the time of acquisition. If the first forecloses, both lenders are barred from getting a deficiency because both loans are classified as “purchase money.” However, where the borrower has refinanced the original purchase money loan, or got a later home equity loan, that later loan is not a purchase money loan and could form the basis for a deficiency if the other anti-deficiency rules don’t otherwise apply.
But there is an exception to the exception: If the later loan was used to finance improvements to the property, then it can be a purchase money loan, and thus be a bar to a deficiency.
3. The Non-Judicial Foreclosure, or “Private Sale Bar”: CCP §580d.
This is the next most frequent rule. If the foreclosing lender has availed itself of the “power of sale clause” in the deed of trust, then no deficiency is allowed. Period. If they take the property back by means of a non-judicial foreclosure or trustee’s sale, then no deficiency. But unless one lender holds both loans, that only applies to the loan actually foreclosed on. Using the above hypothetical figures, though in this case making the second a non-purchase money loan, when the first forecloses, the holder of the first foreclosing loan is barred from seeking a deficiency both (1) Because it is purchase money, and (2) Because it has foreclosed by trustee’s sale. But the second, not being purchase money, and not being the one who foreclosed by non-judicial sale but having been wiped out by the foreclosure of the first, is not barred from pursuing a deficiency. In fact, in California, they have up to four years from the date of the breach of the contract to file a lawsuit seeking that deficiency.
And of course, as noted, there is an exception to the exception: If the holder of the first and the holder of the second are the same lender, and that entity forecloses on the first, it is also barred from seeking a deficiency on the second. This is important in California where lenders sometimes “stack” loans in order to get to a loan amount high enough to cover the high property values. It is also important to think about when the loans may have been sold to different lenders.
(On a historical note, CCP §580d was passed in light of the foreclosures and abusive deficiency judgments obtained by lenders during the Great Depression. What we’re going through now is similar in many respects, though the ability of lenders to take the property and then chase the borrower who is already out of their home is limited by the passage of that statute. Small solace, to be sure, but it at least is doing what it was intended to do.)
4. The fair Value Limitation: CCP 580a; CCP §726(b).
This rule limits the amount of any possible deficiency to the amount by which the total debt exceeds the total fair value of the collateral. It only applies to deficiency judgments in judicial foreclosures, and, most importantly, it does not apply at all to sold out junior lienholders. Example: First mortgage of $450,000, and a second for $150,000, for total liens of $600,000. If the holder of the first forecloses and, it can be shown first at the time the first forecloses it can be shown that the property is only worth $400,000, then the foreclosing lienholder–on return to court seeking a deficiency–is limited to $50,000, regardless of what they sold the property for. So if they pay a commission of 6% ($24,000, and additional closing costs of $5,000, that $29,000 is generally barred. As for the holder of the $150,000 second? They can still come after the borrower for full payment, assuming, of course, such an action isn’t barred by one or the other of the above rules.
5. The 3 Month Rule: CCP §580a.
This rule applies only in the case of judicial foreclosures. What’s that? Literally, it is a lawsuit in which the lender obtains a “decree of foreclosure” from a court–by definition not using the trustee’s sale procedure–and is unable to be made whole from the sale of the property. Example: Loan balance of $500,000. Lender obtains a “decree of foreclosure” from a court, after which it then goes out and sells the property for $400,000. In order to get a recourse judgment against the borrower for the $100,000 shortfall, that creditor must bring an action within 3 months of the sale date or it is barred. An important carve out on this rule is that the 3-month limit does not apply to a sold out junior lienholder, the holder of the second in the above scenarios.
It is highly doubtful that you will have to deal with this rule without being fully aware of the issue steaming down the tracks towards you, simply because it can only happen in a judicial foreclosure. A lawsuit. As to whether or not you’ve been sued, well, you should know it. But check out my prior post Second Mortgages in California: Deficiencies Not Usually an Issue I referred to in my first paragraph above if you’re not sure.
As David Letterman would say, “please don’t try this at home,” by which I mean simply that if you are concerned that you may have a deficiency exposure, call a lawyer. A real estate lawyer, not a family lawyer, a personal injury lawyer or your Grandma Tilly’s trust and estates lawyer. This can be complicated stuff.
And last, of course, if the debt is discharged in bankruptcy, there is no deficiency at all. But that’s another post altogether.
Like everyone else, when I’m reading the various ads in the real estate section, I see quite a few ads for properties being sold “as is.” The suggestion behind this phrase seems to be that this little two-word phrase absolves the seller (and the listing broker) from any responsibility or liability for existing physical defects with the property, or for the need to tell the buyer that certain things that might go awry somewhere down the line. As though it’s a legally sanctioned form of the old “caveat emptor,” or “buyer beware,” which basically puts all of the due diligence job on the buyer. While there is a (very) small grain of truth to this, it is by no means a blanket absolution for a seller regarding known defects.
So then what does this “as is” designation really mean? Resisting, of course, the flippant philosophical observation that almost everything in this world is sold “as is,” as opposed to “as it is not” or “as it might be if all our dreams and fantasies came true.”
California law requires that a seller of real property disclose in writing all conditions and problems that the seller knows or should know to exist. The means by which this is customarily accomplished is through a document called a Real Estate Transfer Disclosure Statement. As far as a seller’s disclosure duties, this is where the rubber hits the road. For those readers who like to read the actual statutes, the language and scope of this disclosure requirement is set forth in California Civil Code section 1102.1. This is a written disclosure, the format of which is specified by law, which requires a seller to go through an exhaustive list of attributes and characteristics and state whether there are any known problems, past, present or reasonably likely to occur in the future.
An “as is” clause does NOT exonerate the seller from the obligation to provide the Civil Code 1102 written disclosures to the prospective buyer, nor from the obligation to disclose known conditions that would affect the purchasing decision of the reasonable purchaser. Also covered are problems that a seller “should” know to exist. What does this mean? It means that even though the seller may not have set foot on the property for 15 years and thus have no idea that the floor boards are rotting to the core, if he or she “should know” that such problems exist, they must be disclosed. Intentionally blind eyes are no excuse.
From the buyer’s side, legally, all an “as is” clause does is put the buyer on notice that the sale is made without warranty, and that the property is accepted in the condition as it appears to a reasonably diligent inspection. As a matter of sound business practice, however, an “as is” clause should alert a prospective purchaser to the possibility of problems and the realization that your inspections should be extra diligent.
So, an “as is” clause is not an “anything goes” pass that allows a seller to dodge disclosure requirements. It is, however, a flag for the buyer that she should look extra carefully because there may be problems of neglect or inattention that a “reasonable inspection” will discover.